Key Takeaways

  • A single-member LLC can elect S Corp status for tax benefits while maintaining liability protection.
  • S Corps allow for pass-through taxation, reducing self-employment tax burdens.
  • To qualify, the business must meet IRS requirements, including U.S. incorporation and a limit of 100 shareholders.
  • Setting up an S Corp requires filing Form 2553 with the IRS and maintaining corporate formalities like payroll and proper bookkeeping.
  • Reasonable compensation for the owner-employee is required by the IRS to prevent tax avoidance.
  • State-level filing requirements and tax rules may vary, such as franchise taxes in some states.
  • Hiring a legal or tax professional can help ensure compliance and optimize tax benefits.

A single-member S Corp is a single-member LLC that has chosen to be treated as an S Corporation for tax purposes. 

Electing S Corporation Tax Status for a Single-Member LLC

A single-member LLC is automatically considered a disregarded entity for federal tax purposes. However, it is also possible for you to choose to be treated as an S Corporation or C Corporation if you are the owner of a single-member LLC. An S Corp is a small company that is closely held.

Because they are pass-through entities, S Corporations are very similar to sole proprietorships and standard limited liability companies. A pass-through entity is a business where income is passed personally to the business owner so that it can be reported on the individual tax return. If you're interested in being treated as an S Corp, you will need to fill out and submit Form 2553 with the IRS.

After you've established your single-member LLC, you can elect to be treated as an S Corp any time you wish. There are certain limitations, however. For instance, your status as an S Corporation must be effective:

  • Within 75 days of filing the IRS form
  • Within 12months after your form was filed

If you choose S Corp status, you will need to file additional end of year tax forms, including Form 1120S, which is the S Corp income tax return.

Both S Corporations and single-member LLCs can be taxed as pass-through entities. One of the biggest differences is that S Corps require considerably more paperwork. The main reason you would choose S Corp status is to lower your self-employment taxes while still having the benefits of pass-through taxation.

When your single-member LLC is considered an S Corporation for tax purposes, you no longer count as being self-employed, meaning you will not have to pay the self-employment tax. Instead of being self-employed, you are considered a company employee. You will also be able to use company profits to pay yourself a salary. However, you may not have access to all available company profits.

Any additional profits earned by your single-member LLC can be withdrawn as dividends, which would prevent them from being double taxed or being subject to employment taxes.

When your single-member LLC is treated as a disregarded entity, the self-employment tax applies to all your company's profits.

Essentially, gaining S Corp status allows you to avoid paying employment taxes on dividends from your company. This leads many people to believe that they should take all of their single-member LLC money as dividends so that they can completely avoid self-employment taxes. Unfortunately, this practice is prohibited. You are required by the IRS to pay yourself a reasonable compensation. Applying for S Corp status for the sole purpose of avoiding self-employment taxes is not the best idea for a number of reasons.

If you're serious about being treated as an S Corp, however, you should consult with an experienced attorney and tax professional to make sure that you have organized your LLC correctly, that your company is following all IRS rules, and that S Corp status would substantially benefit your LLC.

Many single-member LLC owners find it hard to determine what counts as reasonable compensation, as there have been court cases that have listed as many as nine factors for determining this issue. The IRS has a list of ten factors that can be used to determine reasonable compensation. Typically, accountants use a 60/40 rule where 60% of profit is taken as salary and 40% as dividends. Another way to determine reasonable compensation is researching companies similar to your own with the U.S. Bureau of Labor Statistics.

As an example, let's say that you formed a business ten years ago as a single-member LLC. Six years after your LLC was formed you decide to apply for S Corp status. In the previous year, we'll assume that your business was very successful and earned a net profit of $100,000. After doing the proper research, you discover that the typical salary for someone in your file is between $50,000 and $60,000. By paying yourself a salary of $60,000, ensuring you've paid your Medicare and Social Security taxes, and taking the leftover $40,000 profit in dividends, you should not have to pay any employment taxes, thanks to your S Corp status.

Steps to Convert a Single-Member LLC into an S Corp

The process for electing S Corp status involves multiple steps:

  1. Form an LLC – If you don’t already have one, register a single-member LLC in your state.
  2. Obtain an EIN – The IRS requires an Employer Identification Number (EIN) for business tax purposes.
  3. File Form 2553 – Submit this IRS form to elect S Corp taxation. It must be filed:
    • Within 75 days of forming your LLC or
    • Before March 15 of the tax year you want the election to take effect.
  4. Set Up Payroll – As an S Corp owner, you must pay yourself a "reasonable salary" via payroll.
  5. Comply with State Regulations – Some states require separate S Corp elections or impose additional taxes (e.g., California’s franchise tax).
  6. Maintain Corporate Records – Keep minutes of meetings, a separate business bank account, and financial records.

Requirements to Qualify as an S Corporation

Before electing S Corporation status, your single-member LLC must meet the IRS eligibility requirements:

  • Be a domestic entity (incorporated in the U.S.).
  • Have only allowable shareholders (individuals, certain trusts, and estates, but not partnerships, corporations, or non-resident aliens).
  • Maintain a maximum of 100 shareholders.
  • Issue only one class of stock.

Tax Implications of S Corporation Status

The biggest tax advantage of an S Corp is avoiding self-employment taxes on certain business profits. Instead of paying 15.3% in self-employment tax on all net earnings (as sole proprietors do), S Corp owners:

  • Pay employment taxes only on their reasonable salary.
  • Take remaining profits as distributions, which are not subject to self-employment tax.

For example, if a business earns $100,000:

  • A sole proprietor pays $15,300 in self-employment taxes.
  • An S Corp owner who takes $60,000 as salary pays payroll taxes on that amount but avoids self-employment tax on the remaining $40,000.

However, misusing this strategy by underpaying yourself can trigger IRS audits, making reasonable compensation crucial.

How to Determine a “Reasonable Salary” for S Corp Owners

Since S Corp owners must pay themselves a reasonable salary, the IRS considers these factors:

  • Industry norms – What similar businesses pay employees in the same role.
  • Company revenue and profits – A salary should reflect business performance.
  • Time spent on business operations – The more involved the owner, the higher the salary should be.
  • Skills, education, and experience – Professional expertise plays a role in determining fair pay.

A common rule of thumb is the 60/40 rule:

  • 60% of business profit as salary
  • 40% as distributions

Using tools like the U.S. Bureau of Labor Statistics or hiring a tax professional can help ensure compliance.

Failing to meet these criteria may result in the IRS revoking S Corporation status, forcing taxation as a C Corporation.

Ongoing Responsibilities of Running an S Corporation

Once an S Corp is established, ongoing compliance is required, including:

  • Payroll and Tax Filings – S Corp owners must withhold and pay employment taxes.
  • Annual State Filings – Some states require yearly renewal fees or reports.
  • Meeting Minutes & Corporate Formalities – Even for single-member S Corps, keeping records is essential to maintain liability protection.
  • Quarterly Estimated Taxes – S Corps must pay taxes quarterly, avoiding IRS penalties.

Failing to comply with these responsibilities may result in S Corp status revocation or legal complications.

Frequently Asked Questions

1. Can you start an S Corp by yourself? Yes, a single-member LLC can elect S Corp taxation by filing Form 2553 with the IRS. However, you must meet IRS requirements, including being a U.S.-based entity with only one class of stock.

2. What are the tax benefits of an S Corp? S Corps allow owners to avoid self-employment taxes on distributions, reducing tax liability. However, owners must take a reasonable salary subject to payroll taxes.

3. How much should I pay myself in an S Corp? A reasonable salary depends on industry standards, company revenue, and your role. Many business owners use the 60/40 rule, taking 60% as salary and 40% as distributions.

4. Are there state taxes for S Corps? Yes, some states impose additional taxes on S Corps, such as California’s $800 minimum franchise tax. Always check state-specific requirements.

5. What happens if I don’t pay myself a reasonable salary? If the IRS audits your S Corp and determines your salary is too low, they may reclassify distributions as wages, subjecting them to back taxes and penalties.

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